The current market price of one share of Orange Manufacturers Inc. is $40. Assume that its stock
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The current market price of one share of Orange Manufacturers Inc. is $40. Assume that its stock price can either increase by 40% or decrease by 20% each year. A risk-free zero-coupon bond with one-year maturity and a face value of $1,000 has a price of $980. Assume that the yield curve is flat. Use the two-step binomial option pricing model. The contract size for all options listed below is 1 share of stock.
- Calculate the price of a European put option with two years to expiration and strike price of $40 written on the stock of Orange Manufacturers Inc. In few words, explain how you arrived at your result.
- Without recalculating the binomial tree, find the price of a European call option on this stock with strike price $40 and two years to expiration. In few words, state how you arrived at your result.
- Your broker calls you and says that the put option from part (1) is available for $2. What would you do? Is this a good deal? If there is a mispricing, then explain how would you benefit from it. Please be concise.
Related Book For
Fundamentals of Financial Management
ISBN: 978-0324597707
12th edition
Authors: Eugene F. Brigham, Joel F. Houston
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